The next milestone: Islamic banking and finance in Sri Lanka by Muath Mubarak

With a civil war behind Sri Lanka, MUATH MUBARAK highlights the mechanisms needed by the Islamic finance industry to facilitate the country’s economic development.

Today, Islamic fi nance is a thriving industry partly because the benefit derived from the Islamic economic system is more beneficial to society than that offered by prevailing conventional banking practices.

Some developing and developed countries; namely, Australia, Canada, France, Hong Kong, India, Malta, Singapore and Thailand, are actively engaged in building this young and niche market by making amendments to their regulations and legal frameworks.

The miracle of Asia Following the end of Sri Lanka’s civil war, the government is committed to ensuring the country’s long-term economic development. It has already achieved several successes, including establishing the fi rst fully fl edged Islamic bank.

There was a period where Islamic banking and finance (IB&F) was unlikely to respond to the changes needed to meet the aspirations of IB&F in the country. These include providing the basic and more innovative products.

Over the last decade, there have since been many efforts put forward to develop the local industry, such as the establishment of the country’s first Islamic bank.

There is a pivotal need to review and assess all underlying legal and tax systems to nurture, direct and protect

the industry. Otherwise this emerging industry will not facilitate economic development in the country.

This understanding has led countries with complicated tax regimes, such as the UK and US, to the process of reforming and restructuring their tax laws and other relevant regulatory requirements to attract Islamic investors. It is a longterm plan involving constant review to overcome disputes with more workable

solutions.

It is only by ensuring Sri Lanka’s legal and tax systems are aligned with Islamicprinciples that healthy competition among Islamic fi nancial institutions (IFIs) with more innovative business strategy can grow and in turn, develop the economy. This is a strategic investment issue for foreigners from the GCC and other interested parties to invest in Sri Lanka.

The Islamic Finance Focus Group was formed of industry experts in the fi eld of IB&F to work with regulators and other authorities. Following this, law and tax suggestions were proposed in the country’s budget 2011 in order to eliminate the tax barriers and help IFIs to compete and strategically position themselves on a level playing fi eld in the global fi nance sector.

This proposal of tax reformation must consider stamp duty, value added tax, nation-building tax, tax returns and withholding tax. It will be a wide open and unique banking segment to experience the true Islamic banking. There is room to make certain concrete and visible changes in order to allow Islamic finance to prevail in the country.

Corporate governance, compliance and risk management of Islamic banks are also very important to fuel the

industry’s healthy growth. The relevant authorities must make the required changes to mitigate future risks such as corporate failures, scams and collapse of the banks which can occur in the absence of sufficient corporate governance codes.

Once the system is in place it will be easy to monitor the banks’ operations and issue guidelines to direct the financial institutions and banks. This can be done by implementing prudential regulations ratios such as capital adequacy, liquidity and risk management and other financial measurements.

Even though the Islamic capital market in Sri Lanka has a long way to go,some initiatives have given birth to

new ventures aimed at identifying and assisting Islamic fi nance investors to invest in the country. The absence of capital and money market regulations for Islamic fi nance institutions will hinder the growth of this market segment.

Continuous lobbying with the relevant authorities will help address these issues. Recent IPOs in the country have illustrated the expansion of listed companies and can encourage foreign direct investments, particularly from GCC investors. These investors can also invest more eff ectively if the current system is reformed.

A strong foundation for the growth of this industry has yet to be laid down. Lack of research in Islamic banking in Sri Lanka has prevented the market from identifying the industry’s precise growth rate or asset size. Another issue is the lack of human capital in the industry in Sri Lanka.

There are more than fi ve institutions which have been educating the public about the industry while creating some public awareness and promoting the industry by inviting world renowned speakers, scholars and experts.

Yet there is a huge gap between knowledgeable and experienced industry professionals in the market and the

demands of the industry. This is a global issue and needs to be addressed to take this industry to the next level.

With Sri Lanka at peace and making an effort to be the ‘Miracle of Asia’, this will pave the way for the country to grow in leaps and bounds. Rapid infrastructure developments will require significant capital funding. The country can easily attract investors, particularly Islamic finance investors, to these lucrative projects.

Muath Mubarak works in the fi nance control department at Barwa Bank in Qatar and he can be contacted at muath.2009@gmail.com or muath@fi rstglobal-group.com.

This was published by Red Money Group in IFN on 8-Jun-2011